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of cohesion. They can reward the progate while penalising the thrifty.
They can discourage saving. They can be unfair. They can impose high
marginal rates on low earners. They have been used to disguise tax
increases.
ABOLISH NICs
Abolish NICs
Towards a more honest, fairer and simpler system
DAVID MARTIN
They should be merged into the income tax system once an overall tax
cut is aordable.
Price 10.00
DAVID MARTIN
THE AUTHOR
David Martin was formerly Head of the Tax Department at Herbert
Smith. He is a member of the Tax Law Review Committee of the
Institute of Fiscal Studies, was the Special Adviser to the Tax
Reform Commission and is the author of a number of studies on
tax simplification including Tax Simplification: how and why it
must be done (Centre for Policy Studies, 2005), Is the flat tax the
solution to our problems? (CPS, 2005) and Benefit Simplification:
how and why it must be done (CPS, 2009).
Acknowledgements
Support towards the publication of this study was given
by the Institute for Policy Research.
The aim of the Centre for Policy Studies is to develop and promote policies that
provide freedom and encouragement for individuals to pursue the aspirations
they have for themselves and their families, within the security and obligations
of a stable and law-abiding nation. The views expressed in our publications are,
however, the sole responsibility of the authors. Contributions are chosen for their
value in informing public debate and should not be taken as representing a
corporate view of the CPS or of its Directors. The CPS values its independence
and does not carry on activities with the intention of affecting public support for
any registered political party or for candidates at election, or to influence voters
in a referendum.
ISBN No. 978-1-906996-31-4
Centre for Policy Studies, November 2010
Printed by 4 Print, 138 Molesey Avenue, Surrey
CONTENTS
Summary
Foreword by Jill Kirby
1. Introduction
3. Pensions
17
22
26
6. A way forward
29
31
8. Conclusion
34
Bibliography
Appendix: Recent reviews of NICs
SUMMARY
In 2009/10, National Insurance Contributions (NICs) raised
about 74 billion for the National Insurance Fund. NICs also
raised another 20 billion for the NHS. In total, NICs
represented 20% of total government receipts.
Of the money raised by NICs, 61 billion was paid in the state
pension. A further 7 billion was paid in Incapacity Benefit.
Recent announcements indicate that the contributory
principle behind the state pension is to be scrapped. In its
place, a state pension of 140 a week, based on residence
criteria, has been proposed by the Coalition Government. In
addition, expenditure on contributory Employment Support
Allowance is likely to be substantially lower than on
Incapacity Benefit, which is being phased out.
These reforms effectively remove the last justification for the
continuation of NICs.
The problems with NICs
NICs are riddled with anomalies, complexity and a lack of
cohesion.
FOREWORD
As the Coalitions welfare reform programme takes shape, a
number of principles are emerging. Foremost is the
Governments commitment to provide a welfare system that
makes work pay. Integral to this objective is a massive
simplification of the system, replacing a wide range of benefits
with a single universal credit (following the recommendations in
Benefit Simplification, David Martins 2009 CPS report).
The Coalitions latest proposal for a universal flat-rate pension is
consistent with this approach, removing the need for complex
means-tested pension credits or top-ups. Such a universal
pension would also remove the penalty that currently falls on
those individuals who save for a modest personal pension only
to find that in so doing they are merely depriving themselves of
state top-ups to which they would otherwise be entitled.
These moves to simplification, and the removal of deterrents to
working and saving, are welcome. However, it is clear that these
reforms further weaken the contributory principle, since it
appears that neither universal credits nor universal pensions will
be determined by the level of the recipients National Insurance
contributions. The contributory principle is, as David Martin
November 2010
1. INTRODUCTION
On 25 October 2010, plans for a universal state pension of 140
a week were announced in the media. While no official
announcement has yet been made, it appears likely that this
welcome reform will be introduced shortly.
What has not been commented on, however, is how a universal
state pension will remove one of the last remaining justifications
for National Insurance Contributions (NICs).
In 2009/10, the total of NICs collected by government was 97
billion. This was higher than the total VAT collected (84 billion),
and was 67% of the aggregate amount of both income tax and
capital gains tax for that year (144 billion). NICs constituted
over 20% of government receipts of 476 billion for that year.
So NICs are clearly an important source of revenue. Yet what
NICs actually are, who pays, where the money goes, and how
the system works is not well understood.
This paper attempts to throw light on these issues. The
conclusion is that the NIC system badly needs attention. It is
Beveridge was opposed to means-tested benefits. Meanstesting was intended to play a tiny part in the new system,
because in particular it created high marginal tax rates for the
poor, ie. the poverty trap.
The rationale for Beveridge
There are strong arguments for social insurance. Claimants
retain a sense of dignity and self-respect, as they have paid the
insurance premiums for their benefits. Further, because
contribution-based benefits are not means-tested, there are few
disincentives on people to take extra steps, such as saving, to
provide for more than the minimum that is provided from the
state under its social security scheme. It was also intended that
social security would enhance a sense of social solidarity,
because of the pooling together of risks.
What actually happened
It is commonly stated that the Attlee Government implemented
Beveridges recommendations in 1948. But it is important to
understand, however, that many of Beveridges recommendations
were never actually implemented, primarily because of the need
to provide benefits to those who did not have a full contribution
record.
For example, Beveridge had said that a state pension should
not be paid to those with less than a 20 year contribution record
but this stipulation was not practicable given the needs of, for
example, older returning ex-servicemen. Beveridge had also
said that means-tested benefits should be set at a very low
level. But not only were contributory benefits set at levels higher
than Beveridge advised but non-contributory benefits were set
with even higher scales than contributory ones. The meanstested National Assistance thus undermined from the outset
one of Beveridges foundations for his National Insurance
4
72 billion
230 million
126 million
1.7 billion
13
14
HM Treasury, Tax Ready Reckoner and Tax Reliefs, Table 7, November 2008.
those who do not pay NICs, because all get National Health,
whether or not they pay NICs.
As mentioned above, it is clear that there is no formal actuarial
relationship between the amounts of NICs paid and any benefits
receivable as a result. Although the Government Actuary is
asked to confirm that the aggregate amounts paid into the
National Insurance Fund will suffice on an annual basis to meet
payments due to be made from the Fund, there is no attribution
or hypothecation of payments to specific risks or rewards, or
calculations of how NICs are matched to specific benefits. In
other words, the type of actuarial calculations which real
insurance companies need to carry out are simply not done.
It could be argued that, viewed as an insurance contract, the
better-off get a bad deal for NICs paid, because NICs are
earnings-related and they therefore pay more for their benefits,
in particular the state pension. One could also say that the
poorer section of society also get a bad deal, because they are
better off on means-tested benefits and so contributory benefits
have little real value for them.
The low value of contributory benefits
With the exception of the state pension, contributory benefits
are of minor importance in overall welfare provision.
The income of the National Insurance Fund for the year ended
31 March 2009 was 78 billion, of which 74 billion was NICs
received with the balance coming from investment income and
other receipts. Benefits paid from the National Insurance Fund
totalled 70 billion. Of this, 61 billion or 87% was for the
state pension and 7 billion (10%) for Incapacity Benefit. Other
benefits were for smaller amounts for example, contributionbased JSA was just 700 million.
15
3. PENSIONS
It has recently been stated that Britain now has one of the most
complex systems for pension provision in the world.5 The NIC
and state pension system have substantially contributed to this
complexity. Over the years reforms have tended to add layers of
complication and short-term political considerations have
collided with the need for long term and comprehensive
planning.
The state pension is 97.65 a week for a single person and
156.15 a week for a couple (based on full contributions paid).
However the pension credit minimum guarantee is 132.60 a
week for a single person and 202.40 for a couple, irrespective
of contributions paid. A complicated system for allowing NIC
credits clouds the picture further, while the combination of the
state pension rules and the pension credit rules produce a
number of apparent anomalies.
18
21
24
raised only 9.2 million in the five years from 2002/03 that is,
less than 2 million a year.
It is likely that the rules have had some deterrent effect, so that
a percentage of people pay more than the individual personal
allowance tax as salary in the hope of avoiding an IR35 enquiry.
However, the majority of those potentially affected pay little by
way of salary, and instead seek to escape IR35 by restructuring
their working arrangements.
So IR35, for the reasons discussed above, is a cumbersome and
largely ineffective piece of anti-avoidance legislation. It has
failed to prevent the growth of packaged service companies,
which was a key objective of the legislation when introduced in
1999. Between 2002 and 2006 the number of people using
packaged companies more than tripled from 65,000 to
240,000.
It is not surprising that one of the first tasks given to the new
Office for Tax Simplification is to advise how to simplify the IR35
rules. This would help not only the small businesses who are
charged, but also the many thousands of other small
businesses who recognise that they could be affected and try
to arrange their affairs to minimise the risks that they may be
caught. But the root cause of all the problems, it will be noted, is
the NIC system itself.
25
28
6. A WAY FORWARD
The most straightforward way of resolving the above problems
would be to merge the income tax and NIC systems. Indeed this
proposal has already been made on several occasions.6 A simple
payroll tax (based on a set percentage of salary and the value of
any employee benefits) could then be charged to employers.
This would be calculated at a level required to pay those benefits
that are only enjoyed by employees, such as maternity pay, sick
pay and contribution-based JSA etc, and this level would be
lower than that currently charged as employer NICs.
The National Insurance Fund should be wound up.
Pensions would be based on years of residence in the UK.
Pensioners could be compensated for increased tax rates
(because they are not at present liable for NICs) through a
further increase to their personal allowances.
This would not mean that the contributory principle had been
sacrificed entirely. People would become entitled to their
30
32
Timing of implementation
The merging of NICs and income tax will require an overall cut
in the amount of tax received by the Treasury (not least so that
the current advantages enjoyed by the self-employed are
shared by other employees).8
As a result, these reforms would best be implemented as the
economy moves out of recession, when such a tax cut would be
economically feasible.
At present, the self-employed pay 8% of earnings in NICs. The full rate for
employees is 11%, but the contracted-out rebate is 1.6%, bringing it down to
9.4% (this is the correct comparison because the self-employed do not
qualify for the second state pension, and so theirs is a contracted-out
rate).
33
8. CONCLUSION
The problems discussed in this paper are important because of
their direct financial impact.
But they are also important to anyone who believes that an
individual has a democratic right to a broad understanding of
how fundamental matters such as tax and benefits work without
having to take a specialist course of study in the subject. It is
only fair that every citizen should be able to have a reasonable
grasp of his financial obligations and rights to and from
government. The current system makes this very difficult for too
many people.
It would be wrong to say that this is because the problems are
insoluble. But solving them will require a more radical approach
than has to date been adopted.
The most significant financial effect of any reforms is perhaps
the likely impact on state pensions. If it were to be accepted,
however, that citizens should be entitled to a pension simply
based on years of UK residence funded by general taxation, or
if it were decided to pay for the state pension in some other
34
35
BIBLIOGRAPHY
Stuart Adam and Glen Loutzenhizer, Integrating Income Tax and
National Insurance: an interim report, IFS, December 2007.
Nicholas Boys Smith, Reforming welfare, Reform, 2006.
Mike Brewer et al, Pensioner poverty over the next decade
what role for tax and benefit reform, IFS, July 2007.
DSS Deregulation review, Report of the Tax/NICs working group,
1993.
Andrew Dilnot et al, The Reform of Social Security, Oxford
University Press, 1984.
Derek Fraser, The evolution of the British Welfare State,
Humanity Press, 1983.
John Hills, Inclusion or Insurance? National Insurance and the
future of the contributory principle, Centre for Analysis of Social
Exclusion, May 2003.
HMSO, HM Treasury, Income Tax and National Insurance
Alignment: An Evidence-Based Assessment, 2007.
36
an
37
APPENDIX:
RECENT REVIEWS OF NICS
In 1986 a Green Paper was published by the Treasury under Nigel
Lawson. Apart from addressing issues such as independent
taxation, it also looked at the possibility of merging NICs and
income tax. It concluded that there would be cost savings from
doing this, but the penalty of losing the contributory principle
would be too great. The paper pointed out that if the two systems
were merged people who were not in employment would find
themselves funding benefits to employees as mentioned above
this problem would be solved by funding such benefits through a
simple payroll tax. The Green Paper also pointed to the problem of
distributional effects of a merger in particular the kink which
then existed for incomes above the upper earnings limit and below
the higher rate income tax threshold would be affected (which Mr
Lawson referred to as the elephant trap). As mentioned above,
however, the kink has already been removed, and this problem
no longer exists.
However a working group set up by the last Conservative
Governments deregulation initiative recommended full
38
39
40
In any case, NICs are riddled with anomalies, complexity and a lack
of cohesion. They can reward the progate while penalising the thrifty.
They can discourage saving. They can be unfair. They can impose high
marginal rates on low earners. They have been used to disguise tax
increases.
ABOLISH NICs
Abolish NICs
Towards a more honest, fairer and simpler system
DAVID MARTIN
They should be merged into the income tax system once an overall tax
cut is aordable.
Price 10.00
DAVID MARTIN